An Application of Portfolio Insurance Strategies in FOREX market

Ma, Jun (2010) An Application of Portfolio Insurance Strategies in FOREX market. [Dissertation (University of Nottingham only)] (Unpublished)

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Abstract

This dissertation proposes two dynamic capital allocation methods of hedging foreign

exchange risks of payables denominated in foreign currencies. One strategy is synthetic call

option strategy based on currency pricing formula; the other strategy is constant proportion

portfolio insurance (CPPI) strategy based on linear rule.

Monte Carlo simulation is used to test the performance of the strategies. For synthetic call

option strategy, the effect of changing initial wealth on saving performance and hedging

performance is revealed. I find that increasing initial wealth can improve both saving

performance and hedging performance of synthetic call option strategy.

For CPPI strategy, extensive combinations of initial wealth cases and multiples are tested. I

find that different multiples change the distribution pattern of CPPI strategy dramatically. In

general, bigger multiples will reduce the hedging performance but as long as the multiple is

smaller than 21, the floor level can always be protected. Because of effect of changing

multiples on saving performance of CPPI is complicated, I propose saving premium at risk

and minimum saving ratio to seek the optimal multiple for each initial wealth case.

The performance comparisons between synthetic call option strategy and CPPI strategy show

that CPPI strategy dominates the competitor in terms of hedging performance while

synthetic call option strategy has better saving performance on average. I find that the CPPI

strategy is more attractive to hedgers if foreign currency is expected to appreciate while the

synthetic call option strategy is more attractive if foreign currency is expected to depreciate.

I propose a method to improve the hedging performance of synthetic call option strategy

and find that it cannot be used if initial wealth is not sufficient enough.

Item Type: Dissertation (University of Nottingham only)
Depositing User: EP, Services
Date Deposited: 18 Jan 2011 16:23
Last Modified: 24 Oct 2016 19:19
URI: http://eprints.nottingham.ac.uk/id/eprint/24147

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